The budget for 2023-24 will be presented by the federal government in the Parliament in the next few days. There has been a lot of speculation about the budget strategy that will be adopted in this budget. At one extreme, there is the view that it will be an election year budget with a multitude of tax breaks, subsidies, and relief measures.
However, there is need to recognize that the IMF has indicated that if the 9th review of the on-going Program is to be completed the budgetary numbers will need to be shown and discussed with the staff mission. This will put pressure on the Government to pursue the path of more aggressive resource mobilization and containment of expenditure.
Given these opposing pressures, it appears that the Government will need to adopt a more balanced budget strategy which combines additional taxation, especially of a more progressive nature, and achieve significant economy in expenditure.
This should create enough ‘fiscal space’ to provide a modicum of relief to the sections of the population who have been badly hit by rising unemployment and extremely high inflation. The objective of this article is to present such a budget strategy.
The article is organized as follows. Section 1 highlights the key targets that were in the Federal budget for the ongoing financial year. Section 2 presents the likely budgetary outcome. Section 3 then suggests the key budgetary targets for 2023-24.
1. Budget targets for 2022-23
The Federal budget for 2022-23 was ambitious and bordering on being unrealistic. The key targets were finalised following discussions with the IMF and these targets were embodied in the IMF Staff statement after the completion of the seventh and eighth reviews and commencement of the ninth review.
The economy was projected to show a growth rate of 5 percent, with the inflation rate at under 12 percent. FBR revenues were projected to show a growth rate of 21 percent.
The targeted growth rate was effectively higher because the sales tax on petroleum products was to be withdrawn and replaced by the petroleum levy at Rs 50 per liter, with this source of revenue being classified in the non-tax revenue category. Consequently, the implied growth rate in FBR revenues was much higher at 34 percent. This is a growth rate never achieved before. It required additional revenues from new taxation proposals in the budget of almost Rs 900 billion.
The budget as presented envisaged levy of a super tax on large incomes of 1 to 10 percent, taxation of deemed income from property, rise in corporate income tax rate on banks from 39 percent to 45 percent, enhancement in the rate of excise duty on high class air travel and cigarettes. A mini-budget has also been presented in March 2023 to generate an additional Rs 170 billion, with an increase in the sales tax rate from 17 percent to 18 percent.
Given the introduction of a larger petroleum levy, the expectation is that this measure alone will fetch an additional Rs 728 billion in 2022-23. Consequently, an extraordinarily high growth rate of 63 percent was budgeted for the year in non-tax revenues. Overall, Federal revenues were targeted to increase by over 28 percent.
The other very ambitious target is that of limiting the growth rate in current expenditure to only 3 percent. The year 2021-22 witnessed a massive growth in grants and subsidies, especially to the SOEs. As such, it has been rightly proposed to bring down the payment of subsidies by as much as 57 percent and of grants by 5 percent in 2022-23.
Debt servicing was expected to increase by 24 percent. This reflects the likelihood of an escalation in interest rates. Development spending was to increase by 23 percent. Only a modest growth rate of 7 percent was envisaged in defense services.
Overall, the expectation is that the size of the federal budget deficit would be reduced by 19 percent. The provincial cash surplus is targeted to more than double. The size of the consolidated budget deficit is projected at 4.9 percent of the GDP in 2022-23, a big reduction from the deficit of 7.9 percent of the GDP in 2021-22. Further, it is anticipated that there will be a very small primary deficit of Rs 153 billion, compared to the huge Rs 2078 billion deficit in 2021-22.
2. Budgetary outcome in 2022-23
The data on fiscal operations in the first nine months of 2022-23 has been released by the Ministry of Finance. FBR tax revenues have demonstrated a growth rate of 17.6 percent, as compared to the target growth rate of 21 percent. Direct tax revenues have shown exceptional growth of over 46 percent. FBR has achieved some success in making the tax system more progressive.
The higher petroleum levy has led to a big increase in revenues. However, there is still a shortfall in the growth rate of non-tax revenues. The actual growth rate achieved is 26 percent as compared to the target growth rate of over 63 percent.
The big divergence from budget estimates is in the growth rate of current expenditure. It should have been close to 3 percent, instead it is as high as 26 percent. The primary reason is that because of rapidly rising interest rates, the cost of debt servicing has risen by as much as 69 percent. The jump in current expenditure has been countered partially by a cutback in development spending of 20 percent in relation to the level last year.
Overall, the budget deficit stands at 3.7 percent of the GDP in the first nine months and there is a primary surplus of 0.6 percent of the GDP. The last quarter will have to close with a deficit of only 1.2 percent. This is highly unlikely.
Projections of the trends reveal that the consolidated budget deficit by the end of 2022-23 will approach 7.5 percent of the GDP. There is likely to be a shortfall in revenues of over Rs 700 billion, while current expenditure will exceed the budget estimates by over Rs 1500 billion, due primarily to the higher cost of debt servicing. Development spending is consequentially likely to be cutback by almost Rs 300 billion.
The year, 2023-24, will commence with the hangover of a large budget deficit and a primary deficit of almost 1 percent of the GDP. Bringing the deficits down significantly in 2023-24 will be a big challenge.
3. Budget for 2023-24
The Federal budget for 2023-24 is to be presented shortly. As highlighted above, there are wide-ranging speculations about the nature of the budget as to whether it will be an election year budget or a budget which focuses on structural reforms and adheres to the agreement with the IMF.
The macroeconomic projections for 2023-24 by the government are that the GDP growth rate will be 3.5 percent, with the rate of inflation at 21 percent. The growth rate of the economy appears achievable, especially in light of near zero or even negative growth this year. However, limiting the inflation rate will require a sharp decline monthly in the rate from over 38 percent currently. As such, an average inflation rate of 25 percent is more likely.
The critical element in the economic scenario of 2023-24 is the growth in the rupee value of imports, which is the tax base for almost half of FBR revenues. There are indications that the government will strive for achieving a near zero current account deficit in 2023-24, to reduce the external financing requirements. As such, efforts will be made to keep the dollar value of imports close to the level in 2022-23. This will necessitate a continuing process of devaluation of the rupee with expansion in the size of the economy. Consequently, the extent of devaluation of the rupee may approach 30 percent or even more in 2023-24.
The key policy decision is the target to be set for the size of the primary surplus/deficit in the consolidated budget of the Federal and Provincial governments. As highlighted above, this year there is likely to be a primary deficit of over 1 percent of the GDP. As such, if an effort is made to bring it down to zero it will signal a strong balancing of the budget and be acceptable to the IMF. The paragraphs below show how the target of zero primary deficit can be achieved.
The first key target is that of FBR revenues. Given the growth in the domestic tax base and import tax base each of 30 percent, the normal growth of revenues is estimated at 24.8 percent, based on past magnitude of elasticities. Taxation proposals will be required to yield an additional 10 percent, such that tax revenues rise faster than the GDP leading to an increase in the tax-to-GDP ratio of 0.7 percent of the GDP in 2023-24. This implies that the target for FBR revenues will have to be set at Rs 9400 billion, which will necessitate taxation proposals of Rs 700 billion in the budget.
The next target is that of non-tax revenues. The petroleum levy is likely to fetch less than Rs 500 billion in 2022-23, with the target at Rs 855 billion. It is also a flat-rate tax, with low elasticity. The rate will need to be enhanced by at least the rate of inflation to yield significantly more revenues. SBP profits have shown a decline of 22 percent in the first nine months. Overall, an increase of 20 percent in non-tax revenues is feasible, thereby yielding Rs 1875 billion in 2023-24.
Overall, the gross revenue receipts of the federal government can approach Rs 11375 billion in 2023-24. Net of transfers they are likely to be Rs 6015 billion. This will represent growth of almost 21 percent over the likely level in 2022-23.
The greatest uncertainty is associated with the level of debt servicing next year. As the rate of inflation declines, the expectation is that the policy rate of the SBP will gradually decline from 21 percent currently. However, domestic borrowing will need to be fully resorted to, as given the fragile nature of the economy and low foreign exchange reserves it is unlikely that there will be a net inflow of external borrowing. Overall, given the projected stock of government debt as of June 30, 2023, and incremental borrowing needs in 2023-24, the projected magnitude of debt servicing is close to Rs 8000 billion. This implies an average interest rate of almost 17 percent.
There will be a need for significant cuts in other heads of current expenditure. As such, the projected increase in defense expenditure, costs of civil administration, subsidies, pensions, and grants will have to be limited to 10 percent. This implies a combined increase in these heads of Rs 800 billion, which will limit the space for enhancement in remuneration and pensions.
Further, the subsidy to the power sector will need to be limited with appropriate quarterly adjustment in tariffs and improvements in efficiency. The PSDP will also need to be limited to Rs 750 billion, inclusive of loans. Hopefully, enough space will be created for increasing poor-poor expenditures, especially on the BISP (Benazir Income Support Program), by at least Rs 300 billion.
Based on the above targets the federal budget deficit will be close to Rs 8600 billion. The target for the provincial cash surplus should be at least Rs 650 billion, given the relatively fast growth in transfers. Consequently, the projected size of the consolidated budget deficit will be of Rs 7980 billion. This will imply a small primary surplus of Rs 20 billion, leading thereby to achievement of the target of a primary surplus of zero percent of the GDP. This will represent a significant improvement over the likely primary deficit of 1 percent of the GDP in 2022-23.
Overall, the above contours of the budget strategy for 2023-24 are based on realism and include efforts both for reforms to raise the tax-to-GDP ratio and reduce the expenditure-to-GDP ratio. Success in achieving a zero primary deficit as percentage of the GDP will be a true test of the quality of fiscal management and should be acceptable to the IMF, facilitating thereby the completion of the ninth review of the programme.
Copyright Business Recorder, 2023